Jana May Be Betting on a PetSmart-Petco Combo

With its new investment in PetSmart Inc., activist investor Jana Partners L. P. could be betting on a potential merger of the pet food retailer with Petco, a rival firm that was taken private by private-equity firms in 2006. That was the speculation from a handful of analysts Thursday morning after Jana revealed its new 9.9% stake.

In its regulatory filing, Jana asked PetSmart to explore several options for creating shareholder value. Yet it listed a potential sale first in the filing, indicating that pushing the company to consider a sale will likely be the top item on its agenda, if the fund gets its wish and meets face-to-face with management.

Activist hedge funds have had some success pushing floundering retail companies to combine with rivals. Starboard Value LP was a key player behind the recently completed merger of Office Depot Inc. and OfficeMax.

They could look to follow the same playbook by attempting to push PetSmart into the hands of Petco, which was taken private by Leonard Green & Partners L.P. and TPG.

Whether or not the firms would consider a combination of Petco and PetSmart, the buyout of Petco also provides a roadmap for a leveraged buyout of PetSmart, which has negligible debt on its balance sheet and good cash flow.

Kenneth Squire, the founder of 13D Monitor, called a sale of PetSmart to a private-equity firm or to Petco “the best and most likely opportunity” for the company now.

PetSmart said it “welcomes open communications with its shareholders and values constructive input toward the goal of enhancing shareholder value.”

The PE firms did not immediate requests for comment.

Before today, shareholders have been betting on a potential drop in PetSmart’s stock. Short interest in the stock, or bets that the shares will fall, is the seventh-highest among stocks in the S&P 500, according to the research firm Markit.

Investors have been concerned about increasing competition from both Petco and online pet retailers like Amazon.com’s Wag.com. The company has stumbled recently, and cut its outlook earlier this year.

Update: Activist hedge fund Starboard was the activist behind the recently completed merger of Office Depot Inc. and OfficeMax. An earlier post incorrectly said that Jana Partners was the activist hedge fund behind the merger.